The change of outlook to negative from stable follows the recent ruling by France's Conseil d'Etat which cancelled the decision relating to the electricity distribution tariffs for the third regulatory period (2009-2013, known as TURPE 3). Although EDF considers that the decision should not have an impact on its financial results, in Moody's view it adds to the challenges faced by the group from rising debt and pressured profitability. It therefore increases the risk that the group will be unable to maintain a leverage profile that is aligned with Moody's guidance for the Aa3 rating.
The Conseil d'Etat's decision was based on its judgment that the methodology used by the CRE, the French electricity regulator, for calculating the capital return on the electricity distribution network of ERDF, EDF's subsidiary, is incorrect since it did not take account of the nature of the concessions assets and renewal provisions. The distribution network charges for TURPE 3 have therefore been incorrectly calculated. There remains uncertainty surrounding the amount and timing of any remedies that might be required, and their potential impact on EDF. The group itself considers that the decision should not have an impact on its financial results because of the nature of its integrated tariffs.
However, in Moody's view, there remains some risk of a negative financial impact on the group whether from any potential remedy, or from the revised methodology which the CRE is required to propose by June 2013.
The negative outlook takes account of the increase in EDF's net financial debt to EUR39.7 billion at end-June 2012 as a result of its acquisition of Edison; higher capital expenditure; and the rising Contribution au Service Public de l'Electricite (CSPE) balance. It also reflects a flat outlook for the group's profitability in 2013, under pressure from rising nuclear safety costs and weaker power generation earnings in certain markets outside France.
In changing the outlook on EDF's ratings, Moody's takes account of the group's efforts to ease the burden on its balance sheet, and to underpin profitability in order to achieve its 2.5x net debt/EBITDA leverage target. The outlook change factors in the group's ongoing discussions with the government regarding CSPE. Moreover, Moody's notes EDF's ongoing review of its operating costs and capital expenditure (capex) trajectory, which currently includes rising investment in renewables, new nuclear plant builds and its gas strategy.
Nevertheless, Moody's expects the negative pressure on EDF's free cash flow generation to continue, partly as a result of the group's substantial capital investment commitments. These include the Flamanville EPR, the cost estimate for which was recently increased by a further EUR2 billion to EUR8 billion, with planned commissioning maintained for 2016.
The negative outlook therefore reflects the risk, in Moody's view, that measures taken by the group to manage its leverage could be insufficient to ensure its credit metrics remain well positioned against the following guidelines: (1) RCF/net debt in the mid- to upper teens in percentage terms; and (2) FFO/net debt in the high teens/low 20s range in percentage terms.
In light of EDF's 84.48% ownership by the Government of France (Aa1 negative), the group falls under Moody's rating methodology for government-related issuers (GRIs) and its Aa3 rating incorporates a two-notch uplift from its standalone credit quality for potential government support.
WHAT COULD CHANGE THE RATING UP/DOWN
Given the current uncertainties and risks with regard to EDF's cash flows, as reflected by the negative outlook, Moody's does not consider an upgrade of the group's ratings to be likely in the near term.
Negative pressure could be exerted on EDF's a2 Baseline Credit Assessment (BCA) in the event of a sustained deterioration in the group's financial profile, as would be evidenced, for example, by a retained cash flow (RCF)/net debt ratio in the low teens in percentage terms on a sustainable basis. Such a deterioration could result from lower-than-expected profitability, capital investment unsupported by cash flow generation or large debt-funded acquisitions. In the context both of increased demands on national budgets and a two-notch rating uplift under Moody's GRI methodology, it is likely that negative pressure would be exerted on EDF's Aa3 rating were the BCA to deteriorate to a3 from a2.
The methodologies used in this rating were Unregulated Utilities and Power Companies published in August 2009, and Government-Related Issuers: Methodology Update published in July 2010. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.
Electricité de France, headquartered in Paris, France, is a leading integrated provider of electricity generation, transmission, distribution and supply services. It reported turnover of EUR36.2 billion during the first six months of 2012 and EBITDA of EUR9.1 billion.
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